Economics on the small scale

Thursday, March 30, 2006

How to give yourself an economic depression

I'm not sure I completely agree with Professor Black:

CNN's doing a little bit about the impact of rising interest rates on adjustable rate mortgages. I'm guessing we're hitting the point where a fairly big wave of ARMs are becoming untethered from their initial loocked-in rates. Also, interest rates on variable rate home equity loans are heading up...

Somewhat related, the real danger to the economy going forward is the softening construction market.

I think home builders can afford a temporary slow down in their business while their inventory reduces itself. It's the marginal buyers who loaded up on cheap ARMs who might find themselves needing to unload their money-pitshomes as quickly as possible.

There doesn't need to be many of them, just sufficiently many to cause the Real Estate virtuous cycle to reverse itself a bit. A fire-sale induced price drop in other words. A sufficiently serious price drop could trap a significant number of serial refinancers in their homes; now that the easy refinancing is gone, their only course of action would be selling out and taking a loss (that they can't afford) or staying put and bearing it out until they can break even.

If they can break even. If they give up on breaking even, they may just abandon their homes, as happened in Houston in the 80s. Lather, Rinse, and repeat if banks repossess and hold their own fire sales.

Of course, in this sort of environment new home builders aren't going to be able to reduce their inventory unless they too hold their own fire sales.

That would be an awful lot of new and used home inventory chasing a, hmmm, much diminished group of potential home buyers. Pipeline stuffing will do that to you.

Lather, Rinse, and repeat since as loans start defaulting in earnest, banks are most likely to prop up their revenues from new loans to offset old loan losses. That means higher rates and/or stricter requirements for loans, and that means a smaller potential pool of home buyers.

And, yes, while this is going on the construction and banking industries will be contracting and shedding jobs like mad. And it's not clear into what industries those people should switch to. If there was an up and coming industry people could switch to, our labor force participation rate would have recovered a bit better.

With all this happening, the consumer-drivenstarved economy is not going do well either. which doesn't bode well for the stock market and its companies.

The question is how bad is it gonna get, how quickly?


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